The Bank of Canada cut its benchmark interest rate on Wednesday in an attempt to withstand the effects of falling oil prices on economic growth and inflation.
The central bank cut its rate to 0.75 percent from 1 percent, where it had been since September 2010, and it radically reduced its forecasts for inflation and growth for the coming year.
Canada is the biggest foreign supplier of crude oil to the U.S. market and the quarterly Monetary Policy Report of Bank of Canada acknowledged that "the considerably lower profile for oil prices will be unambiguously negative for the Canadian economy in 2015 and subsequent years."
The cut was a shocking surprise for the markets and sent the Canadian dollar to a 5-1/2-year low against USD. USDCAD currently trading at 1.23.
MT4 GRAPH: USDCAD
Analysts had expected the bank to cut its growth and inflation forecasts but did not expect a rate cut. The expectations were, actually, a rate increase in the Q4 of 2015 or early 2016.
The bank explained that it had to cut rates "to provide insurance" against the risks of financial instability and to prevent lower inflation. BOC also acknowledged that household debt levels remain high but the situation is expected to improve soon. The Bank acknowledged that the cut could worsen the housing market in Toronto and elsewhere, however explained that it was more concerned that rapidly falling oil prices could create a housing crash.
BOC is predicting that "a soft landing in the housing sector continues to be the most likely scenario," as Reuters reports. The bank also said that a possible "disorderly unwinding" of household imbalances could have a huge negative impact on the economy and inflation.
Sal Guatieri, senior economist at BMO Capital Markets, in Toronto is quoted by Reuters saying that "clearly the bank is more worried about the economy and missing its inflation target than it is about household financial imbalances and the overvaluation in some housing markets"
The economy growth forecast of BOC changed to 1.5 percent in the first half of 2015, instead of the 2.4 percent it forecast in October, which will broaden the country's output gap.
The bank also cut its 2015 economic growth forecast to 2.1 percent from 2.4 percent. The International Monetary Fund's prediction earlier this week was 2.3 percent.
The bank also said that it expects the economy to reach its full capacity in the end of 2016 now, instead of the second half of 2016.
BOC acknowledged that the most dramatic effect of low oil pricing will be reflected in the overall inflation. The target range of inflation between 1 to 3 percent for most of 2015 is expected to be as low as 0.3 percent in the second quarter. However, core inflation is expected to remain steady at around 2 percent this year.
Stephen Poloz, BOC governor concluded that the overall benefits will outweigh the cost of short-term volatility that might arise from the surprise move.
"We're concerned that (Finance Minister Joe) Oliver and Prime Minister (Stephen) Harper continue to send out mixed signals about the Canadian economy and fail to provide a real plan to address (low) growth. Governor Poloz takes this seriously, he is addressing this through monetary policy, but what we lack is a government with a real economic plan with fiscal and other policies to actually give a jump start to the Canadian economy,” said Scott Brison, finance critic for the opposition liberal party.
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